As states struggle to manage their pension liabilities, Oregon wants to take its fund private

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America’s states have nearly $1 trillion less than they need to pay their public employees’ pensions. While some, like Illinois, are flailing in their efforts to find a solution, Florida recently won the right in court to trim pension benefits and require a minimum contribution from workers, thereby allowing it to close the budget shortfall.

Oregon, however, is taking a different tack. Its legislature is now weighing a bill (pdf) that will turn the Oregon Investment Council, which manages the state’s investment funds—including its pension scheme—into a $74-billion investment corporation with independent governance, thereby placing it beyond the state legislature’s budgetary control.

The Oregon state Treasurer says it’s a necessary move. After some bad calls, Oregon’s current pension system is more than $16 billion in the hole, and a 2003 reform leaves taxpayers on the hook for any liabilities. Then there are the management fees. The fund currently outsources fund management to large private-sector firms, costing the state $365 million in 2011 in fees.

By bringing management in-house, the bill aims to pare down that fee somewhat, but above all it aims to boost the fund’s rate of return by attracting top talent. The way it proposes to do this is important, says Ashby Monk, a sovereign wealth and pension fund blogger:

It’s paramount that public pension funds be able to hire and retain the best and brightest minds…. By taking budget authority for the OIC from the Treasury, this Bill will greatly improve the OIC’s ability to pay competitive salaries and properly resource their investment organization. This, in turn, will lead to it recruiting some top people.

Will this solve Oregon’s problems? That depends on a couple of factors. Most importantly, recruitment. Attracting sharp fund managers shouldn’t be a problem given that, with assets only slightly smaller those of Australia’s sovereign wealth fund, OIC would be a serious operation, not some third-rate pension shop. The question, rather, will be whether politicians know “top people” when they see them.

Still, by bringing operations in-house, Oregon is, in effect, proposing the creation of a sovereign wealth fund—a structure that, at least in theory, aligns the interests of fund managers with those of the retirees who will collect the pensions.

For that, independence from the government may prove important. In many ways, Oregon’s proposed model seems similar to that of the California Public Employees’ Retirement System (CalPERS), which has $252.8 billion under management and, having been around in some form or another since the 1930s, is (with some notable exceptions) fairly professional. However, as Monk argues, CalPERS’ investment mandate has an explicitly political tilt to it—fund officials talk not just about maximizing returns but also such things as helping create jobs in California. This, as we recently discussed in the context of a proposed US sovereign wealth fund, can lead to honoring government priorities over those of retirees. Oregon’s fund, by contrast, appears to be focused solely on returns.